Retreat of Private Sector a Millstone for Beijing’s Next Leaders

To many Australians, China sailed through the global financial crisis, rescuing our economy from recession in the process. For many, this alone is enough to justify giving an A-plus to the leadership.

But there is broad domestic consensus that President Hu Jintao and Premier Wen Jiabao compare poorly with the second and third-generation leaders. Those in power have bequeathed to the incoming fifth generation a strong Chinese Communist Party and rich state, ruling over a fragile country and poor people.

China is frequently characterised as a capitalist economy that is communist in name only. That China has emerged as the world’s largest manufacturer and exporter during the tenure of the fourth generation suggests that they have carried the torch of reform, distancing the country from its socialist past.

While China’s emergence as the world’s factory is impressive, there is a more important domestic story. From 1979 to 1989, domestic consumption was the dominant driver of growth. From 1993 until earlier this century, net exports took the mantle. Since the early days of the Hu-Wen period, fixed investment has become dominant. This is significant. From 2004, Hu has overseen a huge increase in fixed investment. Credible Chinese economists have come to the conclusion this is not just unsustainable but dangerous.

Fixed investment as a proportion of gross domestic product is well over 55 per cent. Such activity is fuelling more than half of China’s growth each year. When you consider that one-third to one-half of these projects offer zero or negative return on investment, a future banking crisis is not just possible but probable.

If non-performing loans were properly classified as such under internationally credible accounting rules, at least two of the four dominant state-owned banks would be technically insolvent.

But the Hu-Wen legacy will be tainted less by economic mismanagement, considerable though this is, than by the engineered advance of the state-owned economy and retreat of the private sector.

To be fair, policies to retake control of the economy were cobbled together by previous leaders in the late 90s as a response to the countrywide riots in 1989 to prevent the rise of an independently wealthy middle class. But the plans to do so were readily accepted, voluntarily extended and accelerated during the Hu-Wen tenure.

For example, the institutional, regulatory and interpersonal links between the CCP and state-owned enterprises were strengthened. Senior management positions within SOEs increasingly became a path to political power and a reward for political officials. The list of sectors designated as “strategic” or “important” by Beijing also expanded, meaning SOEs (or, in rare cases, private companies with extensive CCP links) are well positioned to dominate every major domestic sector in the economy: banking and finance; property; infrastructure; energy and mining; newer fields such as renewables; informational technology; and bio and nanotechnology.

The Hu-Wen team was extraordinarily successful in rebuilding a CCP-dominated corporate state. At least two of the top three executives in almost all SOEs are CCP members. More than 1900 of the 2047 listed firms in the country’s two stock exchanges are majority-owned by the government.

The 150,000 SOEs receive more than three-quarters of all formal bank loans, with the 4.5 million domestic firms receiving less than 10 per cent. In 2009, the three largest Chinese SOEs earned more revenue than the largest 500 domestic private sector firms combined.

That more than 95 per cent of China’s richest 1000 people are CCP members is further evidence that political connections and opportunity are closely aligned.

Despite being two to three times more efficient than even the largest of the SOEs by any commercial measure, private domestic firms actually shrank in absolute number from 2000 to 2010.

The advance of the state and the retreat of the non-state, as some Chinese economists put it, is leading to other unintended but foreseeable social consequences that has weakened China despite its growing economy.

Under Hu and Wen, the revenues of SOEs have increased 15 per cent to 25 per cent each year, while household incomes have risen at a paltry 2 per cent to 4 per cent a year. There are still an estimated 500 million Chinese living on $2 or less a day. It is a little-known but well established fact that 80 per cent of the poverty reduction that has occurred since 1979 took place in the first 10 years of reform, when the private and household sectors—not the state—were given the lion’s share of opportunity and were driving economic growth.

In favouring a small number of well-connected political and social elites, this government is handing over to the next a society that has become the least equal in Asia.

The obsession with entrenching the CCP’s place in China’s economy and society has strengthened party rule and weakened the rule of law in many respects. For example, corruption has only exacerbated the country’s sense of brittleness. Chinese studies suggest that, in the past 12 years, at least 40 million households have had their land seized with inadequate or no compensation, by local government officials looking to raise revenues or personally benefit from the property market.

According to the government’s figures, instances of “mass unrest” grew from a few thousand in the late 90s to 184,000 last year. Beijing now spends at least $111 billion—more than the official defence budget—on a one million strong and military trained People’s Armed Police whose sole purpose is to control domestic unrest throughout the country.

A year after assuming power, Wen defined the paramount task across the next decade as the building of a “harmonious society”. Such rhetoric was seductive, but China has gone backwards by the leadership’s own standards.